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GoldDrivers 2007 - Gold & Inflation

By: Eric Hommelberg

-- Posted Wednesday, 27 June 2007 | Digg This ArticleDigg It!

In cased you missed it gold is coming down lately. Today (June 26) it fell by another $10 and touched its 200 dma for the first time since early 2007. Sure enough bearish sentiment has been propelled to new extremes as a result of this sudden drop and spooked out many investors out of their gold positions. Time to worry? No! Why not?  Well, gold touching its 200 dma is a phenomena we’ve been witnessing once or twice a year since the start of this gold bull market in 2001 and sure enough we’ll be witnessing it many more times in the years ahead. It’s just part of the game. When examining previous bottoms we’ll see that whenever gold touched its 200 dma it entered a ‘BUY’ zone in which it can stay for up to two months before taking off towards higher levels.


Does it mean that gold can’t drop any further from here on?


No, that’s not what I mean, what I want to say is that we find ourselves near bottom levels. Even if gold would drop further from here there is no reason for worry since the worst corrections in gold (since 2001) have been characterized by relative gold values (gold vs its own 200 dma) of 0.95 and needless to say we are nowhere near such depressed levels yet. In order to do so gold would have to drop all the way down to $605. Now I’m not predicting a further drop towards $605, all I want to say is that corrections towards gold’s own 200 dma and slightly below are a normal phenomena in any on going bull market .


So what to do now then?


Well, the only appropriate thing to do right now is to do nothing at all.  This bottom process will most probably end in this price area and as I pointed out in my piece ‘GoldDrivers 2007 – Gold’s Fundamentals still pointing towards $2000+’ there is still plenty of reason to be bullish on the outlook for gold coming years. Always consider yourself what fundamentals launched the gold price from its 22 year low of $250 in 2001 to current price levels around $650 today. What fundamentals changed in order to justify the end of this bull run? The answer is simple. None! In part I we shone a light on gold’s historical average and the US$ and needless to say we couldn’t find any bear argument over there, in contrary, in order to reach new historical ‘REAL’ highs gold should be trading above $2000 levels these days.


In this piece we will shine a light on gold related to inflation:


IMPORTANT NOTE: It’s not my aim to build a case for higher gold prices just on higher rates/inflation alone. Inflation is just ONE of several critical drivers for gold. In part I we discussed gold related to the dollar and its historical norm, today we will shine light on gold related to inflation and next essays will shine a light on other critical drivers like supply/demand/oil and manipulation. 



Gold & Inflation


In part I (gold &US$) I quoted a popular bear tune which wants you to believe that rising rates are being the death knell for gold.  The fact however is that rising rates as a result of a dropping dollar is a strong critical driver for gold which was the case during the seventies indeed when the 10 year yield rose from a mere 5% in the early seventies towards 15% in the early eighties. Gold performed extremely well in that environment since it rose from $35 towards $850. That’s the big picture, please commit this to memory since daily market commentary on gold will get you nowhere. Reading daily market commentary is like staring at noise which troubles the big picture behind it. What I mean is this, gold can move in opposite direction on certain news as one would normally expect. It’s no secret that the big financial power houses (read commercial bullion banks) aren’t very pleased with rising gold prices so they knock gold down on gold bullish news. They do it it such a blatant way that it has become a joke.  Gold experts who endorse GATA’s  claims like eg John Embry, Frank Veneroso, James Turk, Peter Grandich, Doug Casey and Peter George are reporing the counter intuitive moves for years but unfortunately most of the main stream gold analysts still don’t get it..(We will discuss Gold & GATA more in detail in a separate essay). But if you have a good sence of humor you can enjoy yourself by reading daily comments like: 


  • Gold going down on lower oil prices since lower oil prices are a boost for the economy therefore reducing gold’s appeal as an alternative for the DOW. 
  • Gold going down on higher oil prices since higher oil prices are bad for the economy thereby reducing demand for gold jewelry. This will lead to lower gold prices.
  • Gold going down on a higher dollar since a higher dollar reduces the need to for investors to protect themselves (by means of gold) against a loss of purchasing power.
  • Gold going down on a lower dollar since a lower dollar leads to rising rates which in turn could have a devastating effect for home owners thereby impacting the economy on a negative note thereby reducing demand for gold à lower gold prices.
  • Gold going down on inflation fears since a rising inflation would force the FED to raise rates which would strenghten the dollar thereby encouraging investors to sell their gold in favor of the dollar.
  • Gold going down on a rising DOW since rising stocks provide a better alternative for the investor than gold.
  • Gold down on a crasing DOW since investors need to cash in their gold position in order to provide the investor with enough liquidity fast (eg in order to meet margin calls etc....)


Now please don’t think these remarks are exaggerated, just check it out yourself in this video interview  posted on Gold bearish themes as a result of higher rates to come followed by gold bearish tunes as a result of lower inflation rates to come all within 6 minutes, in summary this is being said:


First part of interview: Higher rates à weighing on the economy à weighing on the stock market à downdraft on the commodity markets à 20% downturn in gold


Second part of interview: Experts see a very healthy US economy with low inflation (low inflation is lower rates) 6 months down the road à  healthy for the dollar à pressure on the gold price.




There it is, no matter what the US stock market does, gold should go down, no matter which way rates are heading, gold should go down, at least that’s what many gold analysts want you to believe.


You get it? My point is that daily market analysis is almost completely useless and confusing since it troubles the big picture behind it. Daily market analysis is like discussing weekly weather temperature swings and extrapolating the weekly temperature trend 6 months ahead. But as one can imagine staring at weekly temperature trends is staring at noise which will get you nowhere. In order to get an impression of what weather temperatures could be 6 months ahead it might be a better idea to analyse last years temperature cycle and try to determine where you find yourself this year into that cycle.  The same analogy applies for the gold market as well. Staring at weekly/daily movements doesn’t make sence at all since it doesn’t tell you anything. In order to get a grasp of what could lie ahead it’s better to understand the implications of a massive scale of monetary inflation, one almost never witnessed before.    


Sure enough enough one could argue about the true rate of inflation but I would say if you still believe your government inflation statistics then please forget about gold. The simple fact is that central banks around the world are printing their currencies into oblivion which simply leads to a lower confidence in their corresponding currencies which in turn undermines investor’s willingness purchasing bonds at an ever increasing pace neccesary to keep the system going. So printing money at an ever increasing pace inevitably leads to the only single conclusion possible:


Inflation will roar it ugly head in the years to come.


Please make no misstake about it, the central banks are printing money like if there’s no tomorrow.  The Russian central bank is inflating its money supply at an astounding 57% annualized, the US by 14%, Australia by almost 14% …In fact you won’t find any big powerhouse around the world which is inflating its money supply at less than 10%!!


You really think this is all deflationary? You really think that all this fresh printed money represents real value? You really think the government is telling the truth when they say there is no inflation?

Well, the simple fact is that US inflation rates are running at approximately 10% these days. The official hedonic adjusted inflation rates which the government wants you to eat are a blatant joke. PIMCO’s Bill Gross once called the government CPI numbers a ‘haute con job’ and so does 90% of the american public. 


But how on earth do they (government) manage to report low inflation figures while inflation is on the rise? Well,  reporting low inflation numbers is easy. All one has to do is to remove all items contributing to higher CPI figures. If someone starts questioning for reasons doing so then tell them these items are too volatile to be included. Sure, as long as you don’t have to eat and drive all is well...As said above there aren’t that many people around trusting the government official inflation numbers. When using methodology as during the pre-Clinton era in order to  calculate CPI figures then CPI numbers today would be clocking  figures exceeding  6%, not the bogus 2%+ reported today. John Williams, a specialist in government economic reporting says on his Shadow Government Statistics website ( that current inflation levels do exceed the 10% mark already.


Well, whether you believe the governments stats or not the bottom line is:


A country that prints its currency into oblivion will see its value declining towards its intrinsic value which is zero! As mentioned above with countries like Russia accelerating their printing presses by an astonishing 57% annualized, the US by 14% etc …it ain’t hard to understand which way the value of paper money is heading. The answer is lower! Paper money losing its value simply translates itself into higher inflation numbers.


Now let’s turn to the charts and see what history says about gold vs in flation:




The chart above clearly demonstrates the strong correlation between rising inflation figures and gold. Sure, the official CPI number shows us a comfortable 2%+ inflation rate and the FED has assured us that inflation is well contained. Well, never mind sky-rocketing food prices, never mind sky-rocketing energy prices, all is well as long as you believe the official government stats.


Sure enough you can eliminate oil prices from the CPI calculations but in the end rising oil prices will find its way into higher CPI figures anyhow. Since the era of cheap oil can only be found in financial history books as of today higher energy prices will worm itself into the entire system which will eventually be reflected in higher PPI/CPI stats.


Now let’s take a peek at the oil vs inflation chart: 




This chart shows us a very strong correlation between oil and inflation indeed except for the last few years. The reason is quite obvious since the government is understating real inflation numbers tremendously. As said earlier, the true rate of inflation is about 10%.  


Now we do have a very dangerous mix here which concerns an explosion in US money supply and ever increasing energy prices which in turn could lead to an inflation tsunami sending gold prices to levels unimaginable today. Please be aware that the US money supply increased by more than 100% over the last 10 years. When the US money supply doubled from 1965 to 1974 it led to an average inflation rate of 9.2% per year from 1973 to 1981. When it comes to ever rising energy prices please take into account that the world’s biggest oil fields  producing 80% of world demand find themselves in an unstoppable decline therefore energy prices aren’t likely to come down. (We will deal on this subject in detail in a separate essay ‘Gold & Oil’).


The bottom line is:


Inflation and higher rates are here to come which will benefit gold prices since gold remains the ultimate hedge against inflation.


OK you’ll say, gold as a hedge against inflation but what about the argument of  a collapsing commodity market sucking money out of the gold market?


Well, let me ask you this: the commodity market bottomed out in 2001 and is in a bull trend ever since then, just like gold. Please be aware that commodities today are still dirt cheap compared to their ‘REAL’ highs clocked in the early seventies. In order to reach new ‘REAL’ highs the CRB index should be clocking 1000+, not the 400+ showing off today. You get it? Commodity prices were coming down for more than 30 years and now most analysts are freaking out of so called extreme high valuations after a tiny little 5 year bull move. The chart below shows the CRB index adjusted for inflation and it’s quite obvious that commodities still have a long way to go in order to catch up with previous record highs clocked in the early seventies.




This chart clearly says that both gold and commodities still have a long way to go before they reach new ‘REAL’ highs. A CRB index clocking 1000+ and gold prices clocking $2000+ would be required in order to do so!  


Now please forget about the argument that a reduced economic growth in China would hurt the commodity sector since a reduced demand for commodities could only be achieved by a negative economic growth. The point is I don’t care even if the Chinese economy would slow down to a moderate growth of 8% since it WON’T reduce demand for commodities. It’s the pace of growth in demand that would decline, but still demand would grow! The bottom line is:


Economic growth = increase demand for commodities no matter whether economic growth is 1, 2, 3 or 17%.  Same applies of course for India et all….





  • Inflation took off after the US money supply had doubled from 1965 to 1974 leading to an averaged inflation rate of 9.2% per year from 1973 to 1981.
  • US money supply increased by more than 100% again over the last ten years. Signs of accelerated inflation in sky-rocketing food and energy prices are clearly visible.
  • Higher energy prices will worm itself into the entire system which will eventually be reflected in higher PPI/CPI statistics.
  • Higher energy prices are not the result of an oil crisis but of a demand driven bull market in oil.
  • The end of cheap energy has arrived.
  • Higher energy prices à higher inflation numbers à higher gold prices.
  • Ever increasing energy prices on top of an explosion in the US money supply (increase by more than 100% in last 10 years) is a dangerous mix. An Inflation tsunami could be the result which could send gold prices to levels unimaginable today.  

Despite the fact that the long term outlook for gold remains as bullish as it can get it should be noted that gold’s bearish sentiment these days won’t disappear over night and yes, many analysts are still calling for a further drop as from here. But if you are a believer in gold’s future then these are the time to increase your gold share positions since the gold shares are selling at fire sale prices due to this extreme bearish sentiment. In other words, downside risk is low. Higher gold prices the years ahead will lift the entire gold share sector but the most exciting rewards will come from junior mining companies making new discoveries.


Here at the Gold Discovery Letter we track promising junior companies which we believe could be huge winners before this decade is out. If you would like to participate you could opt for a free trial subscription (one month) HERE.


For the more advanced/experienced investor we just introduced a new discovery mail service which delivers all discovery news within 15 minutes of initial press release to the end user’s mailbox. Sign up info can be found HERE 


Investors who are more interested in general market behavior can opt for our new TGDL chart service by mail which delivers all charts being used here at by e-mail to the end user on a weekly base accompanied with links to related articles. Subscription info can be found HERE


Please feel free to send comments:



Best Regards



Eric Hommelberg


The Gold Discovery Letter/

The Gold Drivers Report



-- Posted Wednesday, 27 June 2007 | Digg This Article


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